Across multiple calculators and analyses, we find the same conclusion that banks and brokers should post margin for beneficial owners lending securities on the DTCC NSCC Securities Finance Transaction (SFT) central counterparty (CCP) through an agent lender. The math works across RWA, Leverage Ratio, operations and daily accrual accounting. While this may be an unpopular opinion and we’ve already heard doubts, we make the argument that for the benefit of the entire industry, borrowers posting margin should be standard practice.
The RWA of CCP calculations are the easiest factor to consider. The 2% risk weight of the CCP is vastly superior to the bilateral credit exposure of almost every other counterparty in the market. New Basel rules of a 100% risk weight for unrated counterparties will be a further imposition. We have run the RWA analysis on several occasions (see Leverage Ratios, SA-CCR and Securities Finance: The New Regulatory Costs of Business for a detailed example or State Street/Finadium: Repo Execution and Pricing Models – A Case Study of Balance Sheet Constraints, Innovation and Client Preferences for a shorter repo example). At this point, we don’t think that any regulated bank borrower would argue the RWA or Leverage Ratio benefits.
Operational benefits should be added to the cost equation. One aspect of that is there’s no chasing for reconciliation of positions since the CCP does that work. While there may always be a need for bilateral reconciliation, placing at least a portion of the business on the CCP means direct savings in headcount and vendor costs as well as removing the general frustration of reconciling small positions that can take up a multiple of resource cost relative to the value of the transaction. There are additional benefits from avoiding the ALD process; the CCP is the ultimate smart bucket for RWA-sensitive borrowers.
Bigger borrower savings can come from getting paid on time. All firms contend with monthly variances for billing breaks that collectively amount to tens of millions of dollars. In a 5% interest rate environment, that unpaid cash adds up. The CCP margin fund pays interest on posted margin and delivers cash on time.
The numbers we’ve heard from agent lenders and borrowers are that agent lenders want price improvement of 35 bps to cover their CCP margin but brokers have offered 5 bps. We think the reality is in the middle. If a borrower has to pay (on the high side) 20% margin (10% for themselves and 10% for the borrower), they clearly need this cash to come from somewhere. Every calculator we’ve built or seen suggests that the savings across balance sheet (no hurdle to repay to internal Treasury) and operations would cover it. If it doesn’t, then the next conversation is pricing of the loan itself in order to generate utilization. CCPs move cash fast to lenders, which means that they can get that cash earning interest. In a rate environment nicely over 0%, that cash pays a notable amount of interest. We still see plenty of programs lending GC at or lower than OBFR to generate cash for this reason. Why not speed up the process and forego agent lender indemnification in favor of “CCP indemnification” while changes are happening anyhow?
The NSCC SFT CCP is a good idea. Maybe not perfect, but DTCC has to work with its regulators for approval and was unlikely to meet the needs of every market participant on day one. In a Basel III Endgame era, it is the best mass market vehicle available to maintain volumes in securities finance by ratcheting down punitive RWAs to the 2% point. While each borrower will have to run their own calculator, we’ll bet that nearly all will agree that they save money by posting margin due to the avoidance of other expenses. Yes, posting 20% margin sounds bad on paper for borrowers, but when RWA, Leverage Ratio, operations and daily accrual accounting are all considered, the CCP is a good deal for all parties.